Advertising budgets in competitive environments

Firms can approach advertising competition either by setting advertising budgets (as in the percentage of sales method) or target sales levels (as in the objective and task approach). We study firms’ incentives to adopt one or the other posture using a two-stage model of duopolistic competition. In the first stage, each firm chooses to commit either to an advertising budget, letting its sales follow from the market response function, or to a desired sales level, promising to adjust its advertising spending accordingly. In the second stage, firms choose the actual levels of their advertising budget or sales target. When prices are exogenous, we show that, due to strategic effects, if a firm benefits from its rival’s advertising (as when advertising increases awareness of the product category) then setting an advertising budget dominates setting a sales target. On the other hand, if a firm is harmed by its rival’s advertising (as when advertising increases the firm’s share of a fixed market), then committing to a sales level dominates. We extend these results in several directions and show that when firms engage in price competition as well as advertising the nature of advertising and product-market competition interact to determine whether setting an advertising budget or sales target dominates.

Amit Pazgal (Corresponding author)Email: